Quiet as it has been kept, benchmark emerging markets exchange traded funds are outperforming U.S. stocks to start 2015. Year-to-date, the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the two largest emerging markets ETFs by assets, are each up 2.4%.
That is an advantage of 60 basis points over the S&P 500. Those performances are better than losses, but are also hardly enough to make investors forget the annual losses posted by those ETFs in three of the past four years. [Returning to Emerging Markets ETFs]
With Russian stocks recovering, Indian shares remaining firm an the liquidity story as prominent as ever in China, some investors are optimistic that the second quarter will be the time emerging markets equities truly begin to shine. Still, some developing economies have proven vulnerable to the strong dollar, underscoring the utility of ETFs such as the Deutsche X-trackers MSCI Emerging Markets Hedged Equity Fund (NYSEArca: DBEM).
The mass exodus from emerging markets may be attributed to the strengthening dollar – as emerging market currencies have quickly declined against the greenback, with the exception of a few like the Indian rupee, U.S. investors have seen even greater declines since a weaker foreign currency translates to a lower U.S. dollar return. [EM ETFs Could be Q2 Leaders]
Like its developed market currency hedged counterparts, DBEM has thrived as the dollar has rallied. The ETF is up 3.8% year-to-date, a 140 basis-point advantage over the unhedged VWO and EEM. Although the Fragile Five has been reduced to the Fragile Three, current account deficits are problematic in some of the MSCI Emerging Market Index’s largest country weights. That spells opportunity for DBEM.
For example, Brazil, biggest coffee producer, the second largest producer of soybeans, third largest of corn and exporter of oil and iron, is witnessing its current-account deficit distend. The country boasted a 1.9% trade surplus of gross domestic product in April 2005, but by January of this year, Brazil is seeing a deficit of 4.2% of GDP, Bloomberg reports.
Turkey’s current account deficit was at 4.8 of GDP but fell to a 27-month low in January. Lower domestic demand and greater exports, supported by a weak lira, have helped reduce the deficit. However, as the country relies on oil imports, any changes in oil prices could weigh on the economy. South Africa is the member of the Fragile Three. [Fragile Three ETFs Face Trade Deficits]
Bolstering the case for DBEM is that emerging markets central banks are not shying away from cutting interest rates to support exporters. This year, central banks in China, South Korea, India, Russia and Thailand, all members of the MSCI Emerging Markets Index, have lowered rates.
Investors are warming to idea of DBEM as a way to play resurgent developing world equities in a strong dollar environment. The ETF has $174 million in assets under management, over $120 million of which has come into the fund this year.
Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF